Key Financials
List: Aktietorget
Market Cap: 1,397 MSEK
Industry: Betting/Entertainment
CEO: Fredrik Burvall
Chairman: Rolf Åkerlind
8.5 points 8.5 points 7.0 points 4.0 points 8.0 points
Share information
Share price (SEK) 99.8
Number of shares (m) 14.0
Market Cap (MSEK) 1,397
Net debt (MSEK) -11
Free float (%) 30 %
Daily turnover (’000) 7
Analysts: Philip Skogby [email protected]
The Profit Rises as a Phoenix
Cherry reported a Q3 which delivered well-above expectation of 154 million
kronor (estimate 143 million kronor). Adjusted EBIT came in significantly stronger than expected at 10.4 (estimated 5.2) exclusive the extraordinary acquisition costs and deducting the minority interest.
The online casino, achieved excellent performance amounting to 107.6
million kronor (expected 96.9) in revenues and significantly improved profitability. Almor has several initiatives to further enhance the growth and profitability rate for Cherry in the future. Yggdrasil grew approximately 160 percent QoQ showcasing its quality games and associated popularity among operators. The staff has increased substantially by over 50 percent to 40 people which signifies the established traction and willingness to expand. It reported revenues of SEK 4.1 (expectation 4.0 MSEK) before internal revenues versus last quarter 1.6 million signifying the projected high-growth trajectory of this entity. The restaurant casino continued to act as a cash-flow generator with revenues of 42.5 MSEK (estimated 42.4 MSEK).
Our SOTP and DCF intrinsic value increased to SEK 140 per share
(Previously: SEK 120) because of the de-risking both financially and operationally by Yggdrasil along with outperformance by the online casino. There are several significant short and long-term catalysts that are ready to progressively close the gap between the price and intrinsic value. The bear and bull case are unchanged being SEK 60 and 200 per share respectively. Operationally, the company is emerging to our bull case scenario.
0 20 40 60 80 100 120
17-Nov 15-Feb 16-May 14-Aug 12-Nov OMXS 30 Cherry
Management Ownership Profit outlook Profitability Financial strength
Summary
Cherry
(Cherb.st)
Redeye Rating (0 – 10 points)
2013 2014 2015E 2016E 2017E
Revenue, MSEK 266 340 524 762 952 Growth 15% 28% 54% 45% 25% EBITDA -24 -18 29 85 173 EBITDA margin -9% -5% 6% 11% 18% EBIT -34 -33 8 58 124 EBIT margin -13% -10% 2% 8% 13% Pre-tax earnings -32 -37 8 58 125 Net earnings -34 -39 0 46 92 Net margin -13% -12% 0% 6% 10%
2013 2014 2015E 2016E 2017E
P/E adj. -9.1 -13.4 -32948.8 30.6 15.1
EV/S 0.9 1.4 2.6 1.8 1.4
EV/EBITDA -10.0 -26.4 47.7 16.0 7.6
2013 2014 2015E 2016E 2017E
Dividend/Share 4.00 0.00 0.00 1.00 1.00
Redeye Rating: Background and definitions
The aim of a Redeye Rating is to help investors identify high-quality companies with attractive valuation.
Company Qualities
The aim of Company Qualities is to provide a well-structured and clear profile of a company’s qualities (or operating risk) – its chances of surviving and its potential for achieving long-term stable profit growth.
We categorize a company’s qualities on a ten-point scale based on five valuation keys; 1 – Management, 2 – Ownership, 3 – Profit Outlook, 4 – Profitability and 5 – Financial Strength.
Each valuation key is assessed based a number of quantitative and qualitative key factors that are weighted differently according to how important they are deemed to be. Each key factor is allocated a number of points based on its rating. The assessment of each valuation key is based on the total number of points for these individual factors. The rating scale ranges from 0 to +10 points.
The overall rating for each valuation key is indicated by the size of the bar shown in the chart. The relative size of the bars therefore reflects the rating distribution between the different valuation keys.
Management
Our Management rating represents an assessment of the ability of the board of directors and management to manage the company in the best interests of the shareholders. A good board and management can make a mediocre business concept profitable, while a poor board and management can even lead a strong company into crisis. The factors used to assess a company’s management are: 1 – Execution, 2 – Capital allocation, 3 – Communication, 4 – Experience, 5 – Leadership and 6 – Integrity.
Ownership
Our Ownership rating represents an assessment of the ownership exercised for longer-term value creation. Owner commitment and expertise are key to a company’s stability and the board’s ability to take action. Companies with a dispersed ownership structure without a clear controlling shareholder have historically performed worse than the market index over time. The factors used to assess Ownership are: 1 – Ownership structure, 2 – Owner commitment, 3 – Institutional ownership, 4 – Abuse of power, 5 – Reputation, and 6 – Financial sustainability.
Profit Outlook
Our Profit Outlook rating represents an assessment of a company’s potential to achieve long-term stable profit growth. Over the long-term, the share price roughly mirrors the company’s earnings trend. A company that does not grow may be a good short-term investment, but is usually unwise in the long term. The factors used to assess Profit Outlook are: 1 – Business model, 2 – Sale potential, 3 – Market growth, 4 – Market position, and 5 – Competitiveness.
Profitability
Our Profitability rating represents an assessment of how effective a company has historically utilised its capital to generate profit. Companies cannot survive if they are not profitable. The assessment of how profitable a company has been is based on a number of key ratios and criteria over a period of up to the past five years: 1 – Return on total assets (ROA), 2 – Return on equity (ROE), 3 – Net profit margin, 4 – Free cash flow, and 5 – Operating profit margin or EBIT.
Financial Strength
Our Financial Strength rating represents an assessment of a company’s ability to pay in the short and long term. The core of a company’s financial strength is its balance sheet and cash flow. Even the greatest potential is of no benefit unless the balance sheet can cope with funding growth. The assessment of a company’s financial strength is based on a number of key ratios and criteria: 1 – Times-interest-coverage ratio, 2 – Debt-to-equity ratio, 3 – Quick ratio, 4 – Current ratio, 5 – Sales turnover, 6 – Capital needs, 7 – Cyclicality, and 8 – Forthcoming binary events.
Significant Outperformance
Cherry’s Q3 report significantly surpassed our expectations concerning turnover on an entity level at 154.1 (expected 143) million kronor. This should also be seen in light of that deposits grew immensely due to Almor and holds significant potential to turn these into gamewin in the future. The growth rate became on an entity level 71 percent (expected 68 percent). Exclusive Almor and Finnish Affiliate sites, depending on their respective revenue composition the revenue would be in the range of SEK 68-75 million – which indeed means that the company reported organic growth of (5-10%) in a generally weak period in relation to the previous quarter. Indeed, in the case above Almor grew by approximately 10 percent by extrapolating the half year numbers. These are highly impressive numbers in any regards considering the competitions growth.
Marketing expenses declined quarter on quarter to 25.5 percent (expected 37 percent) with 32 percent for the previous quarter and still managed to grow immensely during the quarter. Indeed, this shows that the company is now in control of its marketing rather than letting it control the online casino.
In conjunction with that personnel expenses were lower than expected it led to an EBIT-margin surprise of 6.7 (expected 3.6) percent before
extraordinariness and exclusion of the minority interest contribution. COS was a bit higher than expected which we will come back to later which was primarily due to the VAT contribution of Almor. Overall, the company was affected by Almor’s optimal cost structure which brought the margins up considerably and continued with strong growth in
Estimate vs actual
MSEK Q2'15 Q3'15E Actual* Dif.
Revenues 106.7 143.3 154.1 8% Restaurant Casino 39.6 42.4 42.5 0% Growth 13% Online casino 65.5 96.9 107.6 11% Growth 131% Yggdrasil 1.6 4.0 4.1 2%
Growth n.a n.a 339%
EBIT* -5.2 5.2 10.4
Revenue growth rate 40% 59% 71% -20%
EBIT-margin -4.9% 3.6% 6.7% -86%
*Yggdrasil figures: Exclusio n o f Internal Revenues - Exclusio n o f M ino rity interest + extrao rdinaries *So urce: Redeye Research, Cherry
First turnaround in profit for years
its existing business where the personnel expenses stayed largely flat. In essence, the company has now turned its business around with several value-accretive acquisitions on the affiliate and online casino side along with a profitability momentum for its brands. Interesting to note is that the company had 20 percent of its revenues for mobile which is expected to converge over time and subsequently follow or increase beyond its competitors. 10 percentage points more is expected for a quality operator and with Almor releasing its mobile support the path is set to converge to the current 27 percent online casino figure. This is a significant growth catalyst going forward.
The online casino division delivered a turnover of 107.6 million kronor during the third quarter (expected: 96.9 million kronor) thus surpassing the estimates heavily. Moreover, this was likely still affected by high outgoing bonus payments. Unfortunately, we cannot go in detail about the revenue composition of the company between affiliates and direct channeling sales. Albeit, we think the company has a large amount of affiliate sales. The revenue from partner sites is likely significant as well – but it’s important that the company is highly active within this medium to catch the growth from this large customer segment within gambling.
The restaurant casino announced a turnover roughly in line with expectations of 42.5 million kronor (expected: 42.4) which was a strong performance. Review our later section for more detailed analysis of this segment going forward.
Yggdrasil showed considerable results with a reported turnover of 5.3 million kronor (post internal revenues) and 4.1 million SEK pre internal revenues. This figure is estimated to be largely free of setup-fees which indicates that the majority of revenues originate from actual operations amongst the operators. The company also for the first time made the betting numbers (total wagers) public meaning that you could approximate the amount of winnings based on an approximation of the average RTP (Return to player) and amount of retention within each specific game. If the RTP is 95 percent, then payout to player is 5 percent on average (across the games portfolio) times the wagered amount of approximately 1 BN SEK during Q3 would be equivalent to a GGR of SEK 50 million. The
attributable royalty amount is then approximately 10 percent judging by the SEK 5.3 million reported. Indeed, as the RTP decreases the royalty
increases which means that the discount we were previously discussed about seems not to apply to the same extent. Furthermore, we believe the average RTP should be in the range of 95-97 percent depicting which indicate some further higher royalty rate (9-14 percent) than the rate mentioned above. Indeed, for large operators it’s likely that the game
supplier must accept a lower initial rate. Another factor to consider in this argumentation is the theoretical RTP vs
actual which can vary greatly in smaller samples – which is what Yggdrasil Cherry’s report surpassed
expectations of the online casino
is somewhat more exposed to. Thus it might be more or less than the set RTP of the specific slot affecting the debate of the actual royalty rate. Indeed, the mobile amount will be important to follow as it will talk for the retention in the games evidenced by the amount of bets. In September it amounted to 37 percent of its game win.
Nonetheless, with approximately 160 percent QoQ growth these results are nothing short of excellent – the company has not even reached Unibet with all of its games. It just recently added Hero Gaming, albeit not a large casino it’s one of the most innovative casinos at the market indicating once again the attractiveness of Yggdrasil games. In terms of EBIT it was positive in September but we wish that the company utilizes the full-freedom that Cherry gives in order to ensure that its strategy is not short-term optimized. We also want to add that the earnings potential Joker millions, albeit significant, was a bit overestimated due to the actual conversion by the wagering amount into winnings along with a somewhat compensating part of the higher than expected royalty rate. The more correct figure is likely in the range of 0.5-1 million for its Q3 performance – although highly
dependent on the amount of royalty. The company has still three other contracts that is yet to go live, which poses another significant growth driver. In essence, the lower figure for Joker millions means that the operational performance of its slot releases as Chibeasties, Viking Go Wild and Holmes are performing excellent across operators.
This indicates the growth trajectory aligned along with its other newly released top-tier slots. The number of people working is around 40 (up by over 50 percent from Q2!) people and increasing on a step-by-step basis. Significant development can be adhered on its Jackpot slots across operators and the development process of its games. We are expecting more top-quality games releases that will now progressively also take larger shares of promotional campaigns that have been traditionally set for the larger suppliers. The company is set to conquer UK operators with likely better initial royalty rates in 2016 – we expect a license in mid-2016.
On all accounts, the report in general and with developments in late has yet again surprised positively with the underlying fundamentals improved and Yggdrasil being de-risked in the quarter and expect to follow suit in the future. The long-term fundamental case has strengthened significantly the last year for Yggdrasil.
Solid Balance Sheet
Cash and equivalents was 10 million kronor by the end of the second quarter. Strong cash flow generation ahead supports the growth trajectory along with its unused overdraft facility of SEK 25 million. There is an conditional additional purchase price of maximum 18.6 million for Game Lounge which can be paid the earliest of by the end of February. We expect if it would be paid in full it would be paid by shares in Cherry to further align the stakeholders at Game Lounge. It should be noted that the company utilizes funds in order to maintain compliance for its Malta Gaming license.
Cash Flow Effects During The Quarter
Last few quarters we have seen an improvement in underlying cash flow especially between the Q1 and Q2 report for 2015. The Q3-report by Cherry also continued to indicate decent development relative to Q2. There were many one-offs positive and negative along with acquisition related items that affected the current quarters cash flow and as such we feel obliged to try to give a depiction of the underlying cash flow for the quarter.
First, the company took net acquisition costs relating to Almor cash-transaction of approximately SEK 21 million during the quarter. Furthermore, net investments increased due to likely the payout to the Finnish affiliate network acquisition of SEK 11.5 million (equivalent to approximately the price of 1.2 million euro). The remaining increase of approximately 6.5 million we deem could be split between capitalizations which we would consider normal considering its growth orientated state and other related acquisition costs or miscellaneous costs during the quarter. We assume capitalizations was between 3-4 million split between the segments and other related acquisitions costs of approximately 3 million – totaling the approximately the 18 million increase in net
investments for the quarter. The adjusted underlying profitability for Q3 was the following according to
our calculations:
11 million (EBIT) + 6.7 million (Depreciation-non cash flow items) + 2.4 million extraordinary acquisition costs – Capitalizations of approximately 4 million – 3 million minority interest = Around 13 million in underlying cash flow. However, all capitalization costs are likely not maintenance related,
albeit as a security measure we assume it as we can’t pinpoint it. Furthermore, the profit from Almor for May/June affected the company’s
consolidated net cash of SEK 6.5 million (700 thousand euro) but according to the company this did not affect the income statement.
We would welcome more detail in regards to the general effect on cash flow between quarters in the future as possible capitalizations, working capital differences and investments as we can only assume the composition above. It would certainly help in deciphering and thus increasing the accuracy of the underlying earnings power estimation when there is many acquisitions and one-offs involved for this quarter. Nonetheless, the cash-flow trend will The balance sheet
be being easier to read out when the company normalizes its operations the coming quarters assuming no further acquisitions.
Proposing The Rejection of The 2015 Dividend
We have previously been against a dividend for Cherry and this time is no different of our decision and importance. Considering that the company is going forward profitable but that the company is still a small player it is imperative that the company
aggressively takes on new markets and continue to take market share in its markets. There are several other points of interest that is important to notice – improvement of its mobile solution and user experience. The
elevated competitive landscape makes this is a natural ground to invest in. Instating a large dividend can harm these opportunistic features of Cherry
and thus its long-term prospects. Yggdrasil should receive the freedom it rightfully entails and should not be driven on ill-focused short-term objectives in the sake of profitability. Furthermore, historically the company has been able to put its money to decent use considering the development of its businesses.
M&A Opportunities In The Horizon?
Acquiring more companies at a more justified value of Cherry is a tangible opportunity for the company to grow faster than the market and further evolve its brand and product offering. This can be seen as doing multiple arbitrage and can substantially increase shareholder value further.
Although, we cannot determine the time point of this the likelihood of it has significantly increased as the share has appreciated in conjunction with the fundamental development.
The New Cherry Emerging
Cherry has a long track-record of successful acquisitions and Game Lounge and Almor is no exception according to us. The former will enable Cherry to continue to channel customers to its brands and generate revenue also through other brands. Almor will create a stronghold of profitable growth within the German markets. Two of its sites still has no mobile/tablet support with a strong brand and a market poised for growth there exists large potential for future strong growth for this brand. Game Lounge also increased its presence for the Finnish market possibly preparing a strong launch for another Finnish casino (Suomicasino) to concentrate its affiliate efforts on. The Swedish equivalent startup casino is Sveacasino.com where we are excited and following closely and where we expect to see some results soon. The recognition of these efforts now and in the future along with its current brands reaching critical mass volumes will make the market appreciate more of the underlying earnings power of the company. Thus, forming a new depiction of Cherry as a profitable and high-growth company. Nonetheless, the company has significant competition and can likely increase in the future but with Cherry’s innovative DNA it is likely that the company can avoid being significantly hurt. Please review the section starting from P.11 carefully of how and why we asses that Cherry is undervalued.
We believe that the company has acted wisely in betting on a balance of the two elements profitability and growth. High growth will help them
preparing for a re-regulation on the fast growing online casino market via the mobile and organic segments, as well as with the transition away from the physical casino. When the new regulation comes into effect in the Nordic countries, the company will need to be in a position either as a consolidator, or as a potential acquisition object, which will require a sustained greater growth rate in Scandinavia and Europe. From the sole perspective of profitability, it will become essential to obtain a high growth rate to keep a strong profitable position in the market which is experiencing a climate of re-regulation, increased taxation as well as competition – (which is partially compensated by the increased turnover).
Brand Awareness Reflected by Fundamental Improvement
In the table below, it can be observed that the company is allocating significant resources on marketing as it has historically provided an acceptable yield. Now, the trend is clear the company is achieving better return on investment – with scale and efficiency of its market budget the awareness of its brand increases. The MAE-Ratio is on all time high basis (+ 3.5 times the money invested) showcasing the brand recognition, smart marketing and increasing volume advantage. Now, as we will have depicted later in this text is that revenues relative to deposits is more of a challenge for the company to increase its retention of players.
Marketing costs relative to revenues (%) / MAE-Ratio
Source: Redeye research
The company is showing strong signs of an improving MAE-Ratio trend (Marketing Efficiency Ratio – Onlinecasino revenues divided by marketing expenses) which reflects the former deduction.
The company has continued to invest in marketing endeavors for CherryCasino and Spilleautomater during the quarter. It should also be mentioned that the company invested now invests in par with operators such as Betsson, Unibet with a total of 28 percent in marketing expenses and still manages to outgrow them significantly. We think the company should establish itself by investing some resources on the ranking of Casinomeister.com with the experience, platform and trustworthiness. This is not only good for as a marketing strategy but also getting even closer to its customers.
We also believe that the company will reduce COS in relation to revenue to the same levels of the competition – about 20 percent as the online casino division progressively expands beyond that of the restaurant casino in sheer size (which is the primary driver of COS). As of now the royalty rates are likely higher on some its brands due to its relatively low volumes with tier-1 gambling developers.
Number of Players Increased Substantially
The company increased the number of active customers substantially from 26185 to 60300 players during the quarter led primarily by Almor. It is also highly likely that the turnover increased is also driven by Cherry’s
continued efforts and use of CRM/VIP to manage its customers. Although, 426274 new customers were registered during the period which represents a large chunk of the marketing expenses where turning these into active players is important. In turn this depends on factors such as the gaming experience itself, responsiveness and support – these are highly
intertwined. It is essential for the company to make people return and play more
frequently to retain low customer acquisition costs, as the prerequisites Continued substantial
marketing expenses – improvement in the MAE-ratio
CRM and VIP
management continues to implemented
previously mentioned enables. We believe overall the company has
potential in improving and to lower the frequency of bonus utilizing players. What we’d want to see for the next reports is the development of active customer’s post acquisition of Almor for full year in where we can do a more concrete judgement.
Source: Redeye research
As also observed in the previous quarter the reason that the quarter’s high deposit amount was not fully converted to net gaming gains to the same degree is probably due to the higher outgoing bonus payments. The
difference being that Almor is included which indicates the upside potential in turning these into revenue. This is most likely among other reasons being the lack of mobile gaming support which likely will reverse this trend going further. Nevertheless, adjusting bonus amounts in general can be
dangerous as it can detract the ones who actually enjoy playing.
As Cherry has affiliate owned business the company is making money on other sites as well. However, the distribution between direct and affiliate revenues is unknown. We think affiliate revenues are in the range of approximately 30 percent of revenues, with an increasing amount in the
future as the company accelerates this venture. The affiliate costs being the RSA (Revenue Share Agreement) are reported
in marketing costs for its partnership affiliates - the payout for its affiliates depends on a variety of factors like what the operator wants to charge on the affiliate in turn on its customers, usually performed by setting a
progressive payout dependent on Net Revenue per client. It’s better to have a broad affiliate low netting affiliates rather than to have a few very high net revenue affiliates as that would increase the margins for Cherry.
Development of deposited amounts is positive, but a greater amount must be converted
Deposited amount (MSEK)
Source: Redeye research
Yggdrasil – Zenith Launch of Nirvana Approaching
The games have continued to receive good reception at Mr. Green,
Vera&John, LeoVegas as well as Unibet – where amongst others, free-spins’ marketing has been executed with the operators during the quarter. The upcoming game “Nirvana” paves a new way of dynamic graphics,
interaction and game mechanics. This represents well what the company wants to perform, doing things differently to the competition, constantly looking to improve the user experience. Organizationally, the company has the prerequisites to become a fresh twist in this industry with an underlying
genuine passion for developing games. The organization has grown immensely the latest quarters and is now
around 40 people split between Malta and Krakow (over 50 percent growth in relation to Q2). By 2016 the company is expected to grow even more with new games and the strive for developing unique games ensues. We believe that the company must fully utilize its cash flow into these kind of projects to ensure long-term shareholder value. Therefore, Cherry should preferably spend its cash flow and revoke its dividend to ensure that Yggdrasil is long-term aligned and does not have constraint on short-long-term profit
optimization. Of the reported gamewin we expect that GGR is about SEK 30-60 million
goes to the operators (RTP). Then a royalty fee is taken for the game supplied by the RTP level. Thus the company’s royalty rate assuming a payout between 3-6 percent it should lie between 9-14 percent. Increased gamewin likely means somewhat steeper downwards revision initially
considering that it had limited bargaining power initially. At a certain point in time increased gamewin means a downward trajectory
for the royalty levels upon the operator. The analogy here that is important to remember is that one single high-quality game can be worth many times more than a dozen of half-decent games. Furthermore, if the reputation is lost it could be devastating.
Fundamentals pointing towards exceptionally strong growth the coming years
Reception and Prerequisites of Its Games
We interpret the critique and ratings the games have received as evidence of further momentum and Yggdrasil competence within this sector. With an increasing amount of highly innovative slots the company is set to find the jackpot of slots in due course.
The progress the last two quarters has been immense in both dynamics and in-gameplay dynamics pushing the boundaries of its previous games - Chibeasties, Vikings-Go-Wild and Holmes. Indeed, with increased quality of its games we are determined that Yggdrasil with high-quality approach will take part of the marketing budget for games which are important to gain recognition of its games.
Finally, the quality factor relates to dynamics often working in pararell as
variance, modes, mechanics, sound, graphics and general user experience. These neat characteristics we believe the company can utilize to its full
extent. We will follow closely the development of when Yggdrasil deploys its new games across tier-1 operators.
Yggdrasil is delivering its games solely through the HTML5 (iSENSE 2.0) format and platform going forward. Historically, the company has not had complete support for its mobile games, but it is now expected that turnover will increase rapidly even in this segment, which we see as an imperative factor for Yggdrasil’s growth going forward. The old games platform is also expected to be gradually activated for mobile phones by Q1 2016. This of course increase the overall revenue as the iSENSE effect means both that the user experience and downloading is significantly better than porting a solution for each platform.
From a game perspective alone, we believe that the next step for the
company within a year or two, after the company has established a stable customer base, is to customize the games specifically for the gaming operators. This is a trend which will and is emerging for the gambling operators in the industry, one which they would do well to partake in. We believe that this can provide a significant relationship building and associated turnover growth, if it occurs earlier than we expect.
The advantage of the low number of competitors in the game development industry is reflected in the barriers to entry in the form of experience and game design. It should be mentioned that the company is still experiencing a considerable challenge in its efforts to increase the quantity and at the same time being the most imperative factor: to constantly improve the quality of games. This will be a constant struggle for Yggdrasil and we expect that Yggdrasil will act as a challenger to the norm of games developing industry in the future.
The balance between quality and quantity will become increasingly important in the future.
Cherry currently owns 89 percent of Yggdrasil; however, if Yggdrasil’s management members choose to utilize their options, the ownership level will decrease to 86 percent.
The Restaurant Casino Continues to Deliver
The restaurant casino experienced another strong quarter due to continued use of the new cash register terminals. With Cherry’s new cash registers which provide the customers with more payment options we see a tendency that the company can continue to capitalize on quicker payments from the customers. There were a total of 10 new agreements entered with gaming locations and 9 agreements were amended. The company currently enjoys a significant market share of 65 percent compared to 65 percent one quarter before. A negative development is the payroll taxes (increasing from 16 to 25.5 percent effective by July 1st) which we will see the full effect from Q4
which is expected to be shared the restaurant itself mitigating the earnings effect along with further consolidation. It can be quite a hassle for a restaurant to change operator efficiently with fewer organizations involved in the industry. This is necessary for the industry to work efficiently. The division can likely grow by 2-3 percent per year with the help of
acquisitions on the market. According to the company the contraction in the restaurant casino industry is lower than previously and has stabilized at about 2 percent per year.
At the same time, it is possible that a positive outcome of the incoming regulations of the gaming industry will contribute to a doubling of the turnover as well as profits. The cause is that the maximum bet would increase from 70 to 200 kronor in 2016 or later, which may now occur earlier depending on EU’s impact upon the Swedish gaming regulations. Another opportunity is that customers on physical location can register its accounts on Cherry’s online platforms which if executed well can act as an additional revenue pillar.
High turnover due to seasonal effects
The Emerging Fundamental Components of The
Investment Case Cherry:
Before this analysis goes any further we would like to evaluate some critical factors going forward the upcoming years for the readers to quickly grasp. In the following paragraphs we want to list some of the most important value-driving characteristics that the market has now and will likely progressively appreciate for Cherry in the future.
Maturity Phase and Critical Volumes – Margin Expansion
Cherry will be able to cut costs as royalty decrease caused by that volumes are incrementally lifted. Furthermore, as brand awareness increase the marketing budget will become more efficient thus expanding margins. Scale of marketing will also help the company to expand its margins. The personnel expenses base is set to handle higher volumes, thus
personnel expenses relative to revenues will become incrementally more distant. Cutting middlemen such as affiliates are another way to improve revenues in the future. All of these factors Cherry is poised to nurture carefully including that of letting the player to enjoy the playing time to its maximum, thus increasing the retention rate.
The online casino industry is growing but there is also rapid expansion of newcomers that are quickly taking market share. Standing out of the crowd will become gradually more important whether it’s the best and/or
exclusive games, customer service or any convenient or fun feature that makes customers more inclined to play on a certain platform will become more and more imperative to withhold a competitive edge. With the earnings perception of the company changing due to reaching maturity for its brands because of the previous factors a subsequent value appreciation will likely follow.
Essentially, the bottom-line is that we can expect EBIT margins of around 20 percent with a market growth of around 15 percent in a maturity phase.
The Name of The Game is Evolution
The company has recently begun to expand to the sportsbook arena which can create a significant revenue and profitability boost in the future.
Furthermore, its strategy of waiting for the right acquisition works well, this could be a further catalyst in the future. But more importantly, the
company’s internal willingness to search and try out new things is in its DNA. It is no surprise that Cherry has produced both Betsson and Netent. At the same time, it has failed many times as well but if you are willing to learn by your mistakes then success is a natural consequence. With its own games developer Yggdrasil, it is set to expand in a large market.
In essence, the online casino industry is growing but there is also rapid expansion of newcomers that are quickly taking market share. Innovation and excellence is therefore imperative to success. Nevertheless, many markets are its infant stage for regulatory reasons. In the future standing out of the crowd will become gradually more important whether it’s the best and/or exclusive games, customer service or any convenient or fun feature
that makes customers more inclined to play on a certain platform like faster payouts will become more and more imperative to withhold a competitive edge. Cherry has the proper operational prerequisites to satisfy these needs.
Continued Strategic Internal Investments and Acquistions
Historically, the company has performed several value-accretive
acquisitions such as Web resorts and Automatgruppen. Net Entertainment and Betsson is two other well-known internally created brands which has been spun off. Now, Yggdrasil is such an internally created potential for future value growth. Almor is what we deem is a value accretive acquisition over the long-term helping to support further growth in Europe. We can expect more of these acquisitions only if the potential far exceeds the cost even in a negative scenario. This strategy has helped the company to survive over the years and we do not see these fundamentals to transition to the negative for the shareholders in the future.
New Frontier Arenas – Sports Betting and B2B
The SBTech’s betting platform has now launched Q2 bringing Cherry upon the door step for the sportsbetting arena. First, the loyalty amongst existing casino customers may improve as it would provide a choice for betting, but may also improve customer acquisitions of casino customers as new betting players commence playing online. Cherry with a strong brand in the background may likely take advantage of this to create a solid brand for its new betting operations. Now, by Q4 many of its other brands will also go live with this product. This is of course a long-term investment that needs time to yield significant results and resources must be spent on this to achieve results.
Another area of interest is its platform systems which it could sell as a B2B model as both an operator and affiliate systems that in the longer term can be supplied for startups or established operators.
Small Cap Listing
Historically, the management of Cherry has been shareholder friendly. A natural step to realize values of this company is to list itself on small cap, thus attracting institutions. This will lead to easier access to capital. Institutions will naturally appreciate the “risk” diversification of Cherry’s three current primary segments, history, impressive growth rate and the strong ownership.
Yggdrasil Surpasses Expectations
Yggdrasil consists of people with passion of developing fun games. With the increased number of operators and the gradual increase of employees the likelihood of an AAA-slot does not seem implausible. An AAA-slot can stand overwhelm the revenues during a significant period of time due to
one of these. Operationally the company has surpassed our expectations as of yet.
Regulatory Positioning
If the company succeeds in avoiding margin contractions due to
competition, it will result in a strong position in the case of a re-regulated market. It is possible that the company can achieve a multiple expansion as the company then succeeds in sustaining a large market share in
Scandinavia, which would then even be perceived as lower risk generally than a company with smaller market share. Acting in non re-regulated markets is a risk and can spiral into lawsuits which a reaction of this sort can be a substantial opportunity for the investor.
Aligned For Strong Growth
This chapter will present the market dynamics of the three segments that Cherry have operations in.
The Online Casino Industry – Large Potential For
Growth
Cherry can utilize some promising opportunities to obtain a part of the projected growth in the online casino market, which is expected to grow with a CAGR of 5.4 percent in net gaming profits until 2018. The company has a small share of the European market which accounts for 23 billion kronor in net gaming profits, which should make it possible for Cherry to take part of the projected growth due to a greater investment rate than the average market rate.
In addition, it is also expected that the mobile market will become a decent catalyst for Cherry’s future growth which is on average growing by 32% per year in Europe. This would make it possible for a higher growth rate for the company, which we now expect for 2015. We should also mention that it is not certain that the growth in this mobile segment will cannibalize the growth in the PC segment, nor how large this segment will become; we expect that cannibalization will not be an issue for Cherry as a relatively small innovative player. Despite the growth, competition is highly intense in the Nordics and competing at a high level is likely a certification of success in expanding to Europe where markets can be a bit less intense. There is however a possibility of an increase in the Swedish turnover growth rate in relation to the competition, without international establishment,
strengthened by the ongoing transition from physical to online casino (at present only 9 percent of games are conducted online).
We expect that the company can and should achieve growth in Scandinavia to be able to act aggressively in the market when (less if) the regulations are altered. The company may be able to acquire an additional market share of 10-15 percent in Scandinavia, which according to our calculations
represents approximately 500-800 million kronor, which enables the company to position itself for further growth in existing markets.
It will also be strategically important to achieve a greater turnover relative to both minimize the staff expense levels and marketing level without significantly impacting the operating margins. An important question concerning the effects of the impending regulation changes, is in regards to eventuality of decreased sales and lower margins in its wake, where larger competitors gradually enter the market and acquire market share. Most of the gaming operators appear to agree that it is not the case. Rather the the key factor is taxation. A low taxation provides for greater penetration of the online casino market and sustains a highly competitive industry. The Cherry has still only a
fraction of the market share of the total online casino market in Scandinavia and Europe
regulations will lead to lower margins regardless, but it is likely that it will be compensated by a higher turnover level.
EU has accelerated its process for licensing in Sweden by having the Swedish regulations examined at the EU-Commission. With the
government expressing the need for re-regulation a license will likely be granted in 2018-2020 as legal changes tends to generally to take longer than consensus expectations.
It is important for Cherry that if it is to achieve sustained high growth rates through organic growth, partnership or acquisition it needs to expand its operations to other European markets. The regulatory change trends have continued in a few markets during the quarter, such as the Netherlands,
Spain, Great Britain as well as North America.
The Restaurant Casino - Industry Challenges Ahead
The Swedish restaurant casino industry is regulated and Cherry acts under the jurisdiction of the Swedish Gambling Authority. The restaurant casino market represents approximately 1 percent of the total gaming industry, which is a contraction of almost five percent points compared with the millennium shift (before the online casino and Casino Cosmopol’s entry). The potential for Cherry lies in the opportunity to continue consolidating the market and expand the opportunity for customers to play. A catalyst for turnover growth and multiple expansion for the restaurant casino will likely occur at the time of regulatory change in 2018/2019 – which may lead to an increase of the max bet from 70 to 200 kronor. As the question concerning the increase of the maximum bet may not be of the same priority as that surrounding the change of online casino regulations, we expect that it may take additional time before that motion is passed.
The employer contribution raise is also a factor which can come to increase staff expenses, which in turn would reduce operating margins somewhat.
The Game Development Market - Promising Outlook
Yggdrasil, which is connected to the game operator Cherry, is similar to many other game developers, which have historically been linked to game operators to only be sold off later. Example of game developers (suppliers) are Net Entertainment, Playtech, Scientific Games, IGT, Bally Games, and Betsoft. The market for game developers is expected to grow alongside the online casino market. The game developer market is not as competitive as the game operator market, which can be explained by higher barriers to entry. It is important that Yggdrasil continues to remain competitive in the future in regards to both quantity and quality of games, as the gaming operators may otherwise lose confidence in the distributor. Yggdrasil is subject to positive circumstances and opportunities which will allow it to become a significant games developer, considering its experience in the game developer market.
Cherry’s restaurant casino can still grow through acquisitions as well as through easier payment solutions.
Cherry’s Yggdrasil aligned for growth
Financial Estimates
We estimate that for the online casino segment the growth rate will accelerate to 573 million by 2016. The growth is sustained on a high level due to the entrance into new European markets in a more mature stage in the Nordic markets, the mobile growth and less bonus payments. Thereafter as markets mature the growth rate will decrease progressively to 20 percent in 2018. To ensure that this growth is possible, a high investment rate and conquest of market share of the online casino market is required; we believe that the conquest of market share should be possible given the size of Cherry, market growth, experience and innovation along with the capability
of the management team. As the table below indicate is that revenues for the online casino is expected
to grow rapidly, but the yearly growth again is still quite conservative at around 30 percent for 2016. An acquisition can add anything from SEK 100-300 million per year if and only if they find something value-adding which will most likely take time. As mentioned earlier, the accounted revenues are somewhat
underestimated as Cherry has high bonus payouts, which in a mature stage should lead to a greater positive revenue change which will have a direct impact on EBIT in the longer term. Making players play longer at the site increases the amount of gamewin, we believe the company is able to stay innovative in this arena, personalizing the experience to retain players over time. We still think the company has room to surprise considering that we think that the company can further accelerate its marketing. Especially because the growth of Yggdrasil could gain significant momentum during next year with several games for this year in the pipeline. Thus, we have likely underestimated the traction for Yggdrasil 2016 – but we’d think these estimates provides a decent cushion if the company cannot accelerate its games portfolio as fast as hoped and problems with life time value of its games and/or retention. Nonetheless, the British megalodon gambling operator’s revenue contribution by Q3-Q4 2016 should not be
underestimated. It should be noted that these figures are fully consolidated figures with Almor minority interest included.
Estimates
MSEK Q1'14 Q2'14 Q3'14 Q4'14 2014 Q1'15 Q2'15 Q3'15 Q4'15E 2015E 2016E
Restaurant casinno 33.3 35.0 37.6 42.1 148.0 35.2 39.6 42.5 44.1 161.4 156.3
Growth 3% 5% 1% 4% 3.1% 6% 13% 13% 5% 9% -3%
Online Casino 39.1 40.6 46.6 56.8 183.1 58.3 65.5 107.6 118.6 350.0 573.3
Growth 43% 38% 33% 60% 44% 49% 61% 131% 109% 91% 64%
Yggdrasil 0.5 0.8 1.0 0.9 3.2 1.8 1.6 4.1 5.5 13.0 32.1
Growth n/a n/a n/a n/a n/a >100% >100% >100% >100% >100% 147%
Källa: Redeye Research, Cherry
High growth is sustained over time by the mobile venture, the Nordic market potential as well as the establishment in overseas markets.
For Q4 we expect an EBIT of SEK 11.5 driven by the fundamental
optimization its current online casinos and its recent acquisition. These are figures including minority interest of Almor, thus these figures are
somewhat overrepresented but we expect that Almor will be retained by Cherry in the longer term and that its key owner will be retained and rewarded by Cherry shares.
From a margin perspective, we expect improvements in the coming years. Of the reported EBIT above we expect around 70 percent or approximately SEK 40 million representing the online casino contribution for 2016. This is equivalent to an EBIT margin of 8 percent (Pre Almor contribution 25 percent = 6 percent EBIT) under 30 percent growth which seems fair considering the effect of reaching critical mass for several of its brands. This does not seem either unreasonable in relation to other high-growth operators with even better margins like Mr Green, V&J and Guts casino. Thus, it seems like we have a natural margin of safety in this estimate as the brands incrementally become more profitable and efficient. It is possible that in the near future that the margins will increase due to the fact that the fixed expenses are retained at current levels (personnel expenses) which
will decrease progressively in relation over time. Although, the near-term is important, the long term case, to significantly
outgrow the market is likely considering its still low market share in its respective markets with little expansion into European markets. It will likely move increase its presence through a variety of strategies during 2016 e.g. M&A, Affiliate or direct brand establishment. One ought when valuing Cherry to consider the maturity across its top contributing brands across several geographical regions to understand the value of this segment.
Explanations on Important Valuation Parameters
Albeit, the approximately 26 percent marketing rate at the moment is lower than the competitors we expect this figure to ramp up when the company sees opportunities in its existing and prospective markets. When the company continuously reaches scale it should converge to 20 percent. Competitors such as Unibet and Betsson have marketing expenses relative to turnover of 20-30 percent. This goes through all channels affiliate and
Detailed estimates, 2015 - 2016
SEKm Q1'15 Q2'15E Q3'15 Q4'15E 2015 2016
Revenue 95 107 154 168 524 762
EBIT -8.9 -5.2 11.0 11.5 8.4 58.2
Net profit -11.8 -6.8 9.2 9.9 0.5 58.2
EPS -0.88 -0.51 0.66 0.71 -0.02 3.3
Revenue growth rate 31% 40% 71% 68% 52% 51%
EBIT-Margin -9.3% -4.9% 7.1% 6.8% -0.1% 7.6%
Källa: Redeye Research
The relative part of the marketing and COS will shrink in relation to income over time
direct marketing. To be able to acquire further market share in Sweden, the company will need to intensify its marketing efforts to later be in a position to utilize the opportunities of the changed regulatory environment, in other words to be able to consolidate or to be an attractive consolidation target. This we believe is necessary due to the fact of taxation and thereby turnover growth stand-alone will become more difficult in the changed regulatory climate.
COS are also expected to shrink in relation to the revenue when the net online casino revenues gradually increase over time. Royalty rates of its games is usually tied to the amount of revenue. With higher amount of revenue each customer become more profitable all other assumptions being equal. It should however be added that if outgoing bonus payments
decrease, turnover will not need to have a perfect positive relationship since one would lose prospective customers due to revoking bonuses. It is
therefore about fine-tuning to customers whom enjoy playing and frequently at the platform without doing excessive risk arbitrage on the bonuses. Customized and personal playing experience is furthermore important.
Competitors such as Mr. Green for example incur staff costs of 20 percent against Cherry’s approximately 25 percent. When the online casino and Yggdrasil takes a larger chunk of the total revenues the personnel expenses should become lower continuously.
Continued development of the mobile venture is likely to impact the net cash, but it is supported by higher margins in the long term given favorable position in the regulatory changes.
We chose to focus on EBIT as we believe that depreciation will not compensate for CAPEX investments to establish a margin of safety, which are estimated to be higher, which means that we can have overestimated the long-term revenue generation capability if we had focused on EBITDA. All in all, we do not see any reason as to why the company cannot sustain an EBIT margin of 20 percent, similarly to that of the competition or even higher at the maturity stage. Although it is expected to concentrate on profitable revenue growth the coming three years. We have not executed any estimate changes to revenues and EBIT the coming years and quarters.
Valuation
A discounted cash flow analysis and a sum of the parts (SOTP) valuation are used to determine the value of the company.
Discounted cash flow analysis
The turnover growth rate is expected to be 35 percent for the upcoming two years on average – this has increased sales of 2016 from 712 to 762 and 2017 from 890 to 952. Furthermore, the long-term EBIT-margin has been increased to reflect the margin expansion that will occur in the more mature phase of the company. Furthermore, long term growth is adjusted upwards slightly to reflect the fundamental development of the company. The reasoning behind this is the fact that Cherry has experience, strategy and the market circumstances necessary to achieve our estimates. The company will also be in a decent position to consolidate or be consolidated for the upcoming regulations in Europe.
We estimate that the turnover growth rate will decline progressively from the current 30-50 percent the next coming years to 20 percent from 2018. The high growth rate is supported by the higher growth rate experienced by the online casino. The growth rate is also motivated by the fact that the company is absorbing parts of the strong growth experienced by the mobile segment. It is also likely that the company will need to be prepared for further establishments in overseas markets, to be able to reach a maturity stage by the end of 2018.
The EBIT margin will converge to 20 percent on an entity level when the company begins to reach higher maturity of its marketing expenses when it reaches scale. Simultaneously, the restaurant casino’s impact upon the EBIT margin will decrease over time as the online casino’s growth rate increases, which will see COS as well as staff expenses decrease relative to turnover. This will enable it to be possible to achieve an EBIT margin of 20 percent. Even Yggdrasil is thought to provide a positive effect, but we do not asses that it will be major in a relative short-term horizon.
We believe that the company tax will be around 5 percent after 2018 when the company reaches maturity, since the relative part, after profits, from the online casino in relation to the restaurant casino (where they cannot take part in tax advantages) will become substantially larger in the future. Consequently, the tax is expected to progressively decrease to 5 percent. The deferred tax assets will to its majority mean that the tax will be low during 2016-2017 assuming profitability. Unrecognized deferred tax assets amount to around 10 MSEK covering the first SEK 45 million in profits (based on Swedish tax rate of 22 percent)
The essential circumstances necessary to achieve our estimate are in full force
EBIT margins are progressively nearing 20 percent (entity level) in the long term
The Yggdrasil trajectory has pleasantly delivered and is now on the way to barrel through a phase of enhanced growth with games reaching new grounds progressively and operators coming on continuously. As previously explained the prerequisites, operational development and future trajectory resembles an emerging high growth games developer. It is seldom you get to observe a company that seems to have the right prerequisites.
Intrinsic value, which is more of an art than science, should be seen in the light of a dynamic environment, we are putting emphasis on strong growth primarily but also under profitability to some extent in the future for both the online casino and Yggdrasil as they are fulfilling the prerequisites for this trajectory.
It’s important to note that this valuation is based on a long-term view of the fundamental trajectory of the company. Individual quarters can be worse than expected but as long the operational fundamentals do not change significantly: an investor’s perception of the company should not change. Given that the right long-term framework of fundamental development has been figured out.
The profitability rating will be continuously reviewed over the next few quarters and is bound to improve the coming years when the track record of profitable growth emerges.
The DCF value thus now indicates 140 kronor in the base case where the
scenarios can be observed as below:
Scenario summary
For more information regarding the scenario analysis, see page 25.
Bear case scenario: Our estimated value is 60 kronor per share
with an estimated probability of 25 percent.
Base case scenario: Our estimated value is 140 kronor per share
with an estimated probability of 50 percent.
Bull case scenario: Our estimated value is 200 kronor per share
Sum of the parts valuation
A Sum of the parts valuation (SOTP) is used to determine the unique segments values. The aim is to provide a realistic intrinsic value range accompanied with a margin of safety.
The fundamental earnings power of the company is likely to improve during intense growth the coming few years +30 percent as the company reaches scale. This is also led by Cherry’s relatively low market share which we expect is about to change. Own platform, affiliate optimization and SEO optimization, highly experienced management team and unique segments are other factors that warranted a significant revision of the value earlier. The company is reaching critical mass which have now been clearly visible both by growth and profitability in tandem.
As previously we are now even more convinced that Yggdrasil is a challenger in the slot gambling developer industry and will likely be a force within the industry in the next few years. Indeed, we could be far behind on both the online casino and Yggdrasil but this intrinsic value reflects the conviction of us having right in at least one of the two. Thus, in practice one of the segments is enough to fulfill the upside in the long-term. But due to unforeseen risks, shrinking margins for one over time for operators, we must utilize a rational margin of safety. Indeed, soon the cash-flow generator will not be the original restaurant casinos but the majority will likely esteem from the online casino the coming few years and/or Yggdrasil. The sum of the parts valuation is followed below with a chapter following detailed explanations of the reasoning behind the valuation:
Sum-of-the-parts valuation
Segment
Value
EV/EBIT'16E
OwnershipOnline casino 1242 11.4 100% Restaurant casino 106 8X 100% Yggdrasil 600 86%** EV 1948 Net Cash* 10 Equity value 1958 Intrinsic value 140 Market value 1400 Stock price 100 Upside 40%
The multiple have gone up for the online casino by 1.4 points or 14 percent since last report reflecting the subsequent de-risking of this segment. For the same reason Yggdrasil has increased from 560 to 600 million during the quarter. The growth per year does indeed seem overwhelming from around SEK 350 million in 2015 to around 600 million in 2016 for the online casino. But, one must set that in to perspective first from Q3 Cherry’s ongoing business will have more than approximately 440 MSEK revenue stream assuming no growth. Thus, the actual growth is actually in the range of around 30 percent. Secondly, Cherry has still a low market share in its markets accompanied with decent prerequisites and with a growing market the company is set to grow.
Reasoning Behind The Valuation of The Online Casino
If we assume that the company can sustain an EBIT margin of 19-20 percent at the maturity stage, at a turnover of approximately 570 million for 2016 (annual rolling basis - assuming no growth - is currently SEK 440 million), this will lead to a value of an EV/EBIT multiple base of 11.4 equivalents to approximately 1.2 billion kronor. This is still a somewhat conservative multiple when considering the company’s extensive experience in the gaming industry as well as the fact that the company has succeeded in sustaining a high growth rate. Consider that the company by 2017 will emerge to Mr Green’s revenue level of approximately 650 million, the margin of safety, in this investment becomes evident. Indeed at the previously disclosed margins along with that it can start trading at a 15-20 multiple considering it’s highly shareholder friendly ownership would mean 1.5-2BN SEK in valuation. The revenue momentum is set to expand far beyond 2017 according to our estimates establishing its brands across Europe. Thus, continuously as year progress and the competition intensifies and the associated impact of unfavorable regulations will thus give an margin of safety for the current valuation. This is why we are certain to include even the projected share of minority interests (furthermore we expect that Cherry will also obtain the remainder of the minority interest in time). Further value-accretive acquisitions cannot be excluded and is a significant catalyst, despite its considerable time to make the right acquisition.
Unibet and Betsson are traded at approximately 20x EV/EBIT for 2016E, with a significantly lower organic growth rate. A risk premium should however be supported as the company is smaller and operates in fewer markets, which raises the political risk.
The case is based upon a growth rate which is determined by how well the company manages to sustain the momentum within its brands, the mobile integration as well as how successful the overseas establishments are over time. The margins at the time of the maturity stage will then be appreciated by the market as the company will then take action to introduce a stable dividend payment based on the cash flow.
The net casino division for 2016E is in principle the foundation of the current MCAP today
As mentioned earlier, the chosen EBIT margin is not only a product of the reduced marketing expenses and personnel costs, but also due to the reduced bonuses. Even at a 10 percent operating margin the highly probable growth makes the company poised for higher valuation. Thus even if the highly intense competitive climate decreases the margin the strong growth provides a safety cushion for the valuation.
Restaurant Casino Stable Cash Flow Generator
The restaurant casino which certainly has a lower growth rate, however, with a catalyst in the form of a hastening of the re-regulation within a not too far off future, along with the payment solutions and acquisitions impact on the turnover; we believe that this division can be valued to 105-124 million kronor or an EV/EBIT of 8 – 9 with an expected turnover of 152 million kronor and an operating margin of approximately 9 percent. One should also take into account the fact that an international player would likely appreciate the significant market share the restaurant casino
possesses, which may suggest that we have underestimated the multiple or the acquisition multiple for the division. Another factor as previously noted is the increase of the maximum which can double
Yggdrasil – The Versatile Slot Machine
Yggdrasil if sold on the market today, could as previously indicated obtain a value between 50 to 70 million kronor but we now believe the range is more like 130-150 million kronor as the company annualized is achieving 16 million in sales already assuming no growth (assumption: 86 percent ownership of Yggdrasil). This, however, does not reflect the potential of a long-term owner’s valuation of the company. The games has already been proven to work by tier-1 operators and it is now in a stage to take their game to another level. This includes further better and innovative slots, taking further share of the marketing campaigns by continuously improving relations with operators. With reason to believe that the likelihood of growth as well as margin expansion is likely, based upon what has been achieved in terms of revenue performance, as well as the fact that full support for the mobile platform is expected, this makes the current valuation reasonable.
In addition, we assess in the long term it is likely that the company can obtain a good yield from Yggdrasil, which can be expected to produce a similar EBIT to that of Net Entertainment of 30 percent or more, depending on if they take decisive action in the regulated or re-regulated markets. Net Entertainment is valued at about 25-30 its earnings power of the current year in which a conservative scenario should be able to motivate a multiple of 10-13 for a smaller company, but for a fast growing company such as Yggdrasil the multiple should actually be higher, given the abnormal growth rate. This will produce a multiple expansion for the company when volumes
similar to that of the online casino are achieved. It would not surprise us if High multiples for game
developers support a high valuation of Yggdrasil
the 86 percent ownership in Yggdrasil would represent a majority of the market cap value in the future for Cherry as an entity. When the company reaches a turnover of approximately 100 million, Yggdrasil will then be valued by an operating margin of 30 percent at the maturity stage; a
multiple of 20-30 implies that Yggdrasil can be valued between 600 – 1,000 million Swedish kronor in an initial maturity phase. As time surpasses the value can extend far beyond this point. 2BN SEK+ cannot be neglected thus alone standing for more than the current price today. As such one receives a substantial margin of safety even if the other businesses fails. This is a contrarian notion but an important one - the actual currently present add-on value optiadd-on of Yggdrasil could indeed switch places with the current primary value contributor of the online casino in the longer-term. If it is required, due to conflict of interest opinions, the company should be spun off or sold off which should also result in a profitable venture for existing shareholders. We believe that is unlikely that the company would choose to sell of the division to a larger organization as it is with great probability that the management/owners will see the potential for a significant value realization in the longer-term. Even to the extent that Yggdrasil becomes the primary segment of Cherry in the future.
Summary valuation
Our base case results in a valuation of 140 kronor per share, and in the bear and bull case scenario the valuation is 60 and 200 kronor per share
respectively. The sum of the parts valuation also resulted in a value of 140 kronor (including Yggdrasil).
Investment Case
Cherry is in an exciting phase of the development of its online casino as well as the game supplier segment. Cherry has driven and sold a number of online casinos in the past. Cherry has now turned its business around showing profitability and enabling further investments in its current business. Albeit, margins could still be enhanced but for the coming years they will likely further expand in new markets and existing. If one adjusts the online casino’s expenses the online casino will then still motivate a large of the intrinsic value today.
As Cherry uses an active strategy to retain its customers through different
innovative methodologies more customers sign up and are retained. A center-piece in this aspect is its mobile focus which we assess to be a
positive catalyst for greater growth as it improves this product continuously. We believe that the company only needs to grow in Scandinavia and in Europe to achieve our long-term estimates. This strategy in combination with decent acquisitions makes it possible to achieve a growth which exceeds that of the market. The acquisition is one of these steps to expands its business in Europe and we are expecting more of these initiatives.
Furthermore, the online casino operation has a profitable restaurant which is yet to be priced by the market. The restaurant operation has a turnover of approximately 150 MSEK and an EBIT of 15 MSEK and possesses a market share of 64 percent in Sweden. In terms of market share, a potential acquirer can, in the possible form of a game operator, see value in the large market share but also be able to impact on the range of games on offer. The market is not currently pricing the restaurant operations or the potential for an increased market share today. In addition, the eventual changed
regulations of the maximum bet from 70-200 kronor in 2018/2019 may double the turnover as well as the operating profit.
Cherry has a significant potential to acquire market share within the game development industry, as Yggdrasil which is driven by experienced people, is already now renowned amongst the operators and will be able to compete with Net Entertainment. The team is relatively small, but plans to expand as more contracts with gaming operators are entered into and in order to continuously improve its games.
The significant risks for Cherry lie to an extent in the company’s high concentration in Scandinavia, which in the case of disadvantageous regulations could reduce the profitability of the company initially and partially due to a significant increase of competition within the online casino segment.
